If you have wondered about using home equity to pay off debt, you aren’t alone. When debt from unpaid bills, loans, and credit cards piles up high, it is only natural to look for any solution to dig yourself out. Eliminating debt is a worthy goal, one that opens your future up to many possibilities, such as preparing for retirement or living more comfortably.
There are several ways to pay off your debt, but some methods are better than others. Using home equity to pay off debt is definitely an option, but it is a risky one. Let’s take a look at how home equity can be used to pay off debt, why it isn’t the best path to eliminating debt, and some better alternatives for debt relief.
How Can Home Equity Pay Off Debt?
Home equity is your stake in the ownership of your home—how much your home is worth minus how much you owe on your mortgage. Homeowners can leverage this equity to pay off debt. There are two ways you can do this:
- Home equity loans: A lump-sum loan, used as a second mortgage against your home, that you can use to pay off your credit cards, student loans, and other debts.
- Home equity line of credit: A revolving line of credit using your home’s equity that you can borrow against as you need it. Instead of receiving a lump sum, you can withdraw money as you need it. Like a credit card, you take out what you need and repay it over time.
As a tool for repaying debt, home equity loans are more appropriate and helpful, though a home equity line of credit can be used to cover payments on loans.
The Problem with Home Equity Loans
On paper, using home equity to pay off debt sounds like a great deal. You take money that you aren’t using because it’s tied up in an asset, liquidate it, and put it toward an immediate expense. Plus, home equity loans have low interest rates. You can turn piles of monthly bills into one single, simple, low-interest payment. Having only one payment will simplify your life and make it easier to remember to pay on time. That sounds like a great deal, but there are two major problems with using home equity to pay off debt:
- Your home is on the line. A home equity loan is a secured loan, which means that it is backed up by an asset: your house. Having your home as security on a loan is what makes it possible to get such a low interest rate. That means that any missed or late payments puts your home at risk of foreclosure. The risk of losing your home is not worth the benefits of consolidating and paying off your credit card debts.
- You might build a mountain of debt. The threat to your home will escalate if you continue to add new debt after taking out a home equity loan. For example, if you open up more credit cards and pile on new debt, you’ll be responsible for more payments in addition to paying off the home equity loan. If you don’t make significant changes to how you manage your money, you could find yourself under a growing mountain of debt.
Alternatives to Using Home Equity to Pay Off Debt
Home equity loans and lines of credit are not your only option for paying off debt, and certainly not your best option. If you are serious about getting out of debt, try these alternatives first:
- Personal loans. These loans have higher interest rates, but they aren’t secured and don’t carry the threat of losing your home if you fall behind on payments.
- Balance transfer credit cards. Transfer the balances of your credit cards to a 0% APR card, which carries no interest periods from six months to two years. This might be enough time to move your balances over and pay them off without interest. Typically, these cards are hard to qualify for unless you have excellent credit.
- Debt relief. Seeking help from a debt relief company can help you get out of debt without risking your home, and may help you pay off your loans faster than you could with just a personal loan or balance transfer credit card.
- Make a plan. Work with a debt relief professional to come up with a strategy for eliminating your debt. This may involve debt consolidation and creating a budget that will help you smartly tackle your debt payments.
Debt is a heavy burden to carry. It is normal to want to do anything to get rid of it so you can have the freedom of a bright financial future. There are a number of ways to reduce and eliminate debt, without putting your home at risk. Using home equity to pay off debt is possible, but not a recommended method.
Do you need help tackling your debt? Get a free debt assessment today from CreditAnswers.